What type of tax-planning opportunities can companies take advantage of as 2006 comes to a close? What does 2007 hold?
“There are numerous issues that companies should be aware of,” says David H. Benz, partner and director at Sommer Barnard PC. “For instance, the Pension Protection Act (PPA) passed this year includes new rules and several important tax measures. Also, while not part of the PPA, the Dec. 31, 2006 plan compliance deadline previously set for non-qualified deferred-compensation plans has been extended to Dec. 31, 2007.”
Taxation may arguably be one of the most complex areas of law, and Benz notes that it’s important to keep up with changes on an ongoing basis. “Clear communication with internal accounting teams and good relationships with outside advisers are crucial to success,” he says.
Smart Business recently asked Benz to discuss some major considerations for 2007.
How can businesses take advantage of year-end planning opportunities?
Year-end planning is basically a combination of deferring income and/or accelerating deductions. For instance, cash-basis companies can accelerate deductions into the current tax year by pre-paying certain expenses, such as utility costs, employee benefits, and in some cases, rent. On the other hand, if the expense is for a benefit lasting longer than 12 months, pre-payment will not create a current deduction. As for accrual-basis companies, bonuses paid within the first 2 1/2 months of the next tax year and certain other recurring items can be deducted in the current year.
What last-minute items should a business consider?
Year-end planning involves looking back to the previous 11 months. For example, this year’s deduction for domestic production activities is equal to 3 percent of the lesser of a business’s total taxable income or the business’s qualified production activities income for the year. However, the deduction is further limited to 50 percent of the business’s W-2 wages paid during the year. If a business engages in some year-end planning, an otherwise available deduction that is limited by the W-2 wages paid year-to-date can be increased by making additional bonuses before year end.
What do businesses need to know about the Pension Protection Act (PPA) passed this year?
Primarily a reform effort aimed at defined-benefit plans, the PPA also includes several important tax measures. For instance, there are new rules affecting charitable donations, recordkeeping and corporate-owned life insurance. The PPA also makes permanent some of the tax benefits enacted in 2001 that were originally set to expire in 2011, such as qualified tuition programs and Roth 401(k) plans.
The PPA made favorable additions to ‘safe-harbor’ plan design for 401(k) plans. Specifically, it added a new auto-enrollment/safe-harbor alternative. If a company opts for auto enrollment and also complies with certain requirements under the PPA’s new safe-harbor rules, it will be guaranteed to pass the nondiscrimination tests that have burdened some plan sponsors. Neither auto-enrollment nor safe-harbor plan design are new. Rather, I think the real importance of these provisions is two-fold. First, automatic enrollment should result in increased participation by rank-and-file employees. And second, the new provisions should make safe-harbor plan designs more palatable to a wider group of employers.
While some commentators are dubious that these new provisions will be of much use to large employers, I think all plan sponsors should engage in some type of cost-benefit analysis to determine whether auto-enrollment/safe-harbor makes more sense than the traditional nondiscrimination testing.
How can businesses prepare for 2007?
Arguably, one of the biggest changes coming in 2007 is a financial accounting interpretation. In preparing for tax planning in 2007, businesses should be familiar with and prepared for this new interpretation that is certain to have a profound and far-reaching impact on any taxpayer issuing GAAP financial statements.
By examining tax return positions, FIN 48 will govern the way in which a taxpayer books income tax expenses and balance sheet tax assets/liabilities. FIN 48 abandons a ‘probable’ standard in favor of a two-step approach. First, the taxpayer’s return position must be ‘more likely than not’ correct, arguably a lower standard than ‘probable.’ However, in the second step, the taxpayer must handicap its likelihood of ultimate success, considering not only the technical merits of a position but also its willingness to settle for less than 100 percent. It is the result of this second step that is then booked on the taxpayer’s financial statements.
DAVID H. BENZ is partner/director, Tax Group chair and a member of the Business Practice Group at Sommer Barnard PC. Reach him at (317) 713-3500 or email@example.com.